Educational Articles

And Then There Were Three: Microsoft and the Future of Mobile Operating Systems

Sharif Abdou
| June 13, 2011

Battle lines are being drawn in the mobile computing space. While the field is crowded with hardware and software makers contending for the hearts and minds of consumers, many within the industry believe the circle will ultimately narrow down to three dominant platforms. Few doubt that tech trendsetter Apple (AAPL) or Internet search giant Google (GOOG) will make it to that select group. But gaining entry to that exclusive club will undoubtedly require vast resources, pinpoint marketing, and a highly competitive product. In Part 1 of our 3-Part series, we take a look at software giant Microsoft (MSFT - Free Microsoft Stock Report), and its chances of breathing this rarified air, below.

It’s hard to think of Microsoft as an underdog. A tech sector staple for decades, the company has become synonymous with size and market power. In fact, about 85%-90% of desktop and laptop computers around the world are running some iteration of Microsoft’s Windows operating system (OS). Further, with a market capitalization north of $200 billion and more than $40 billion in cash and short-term investments on hand, Microsoft is no one’s idea of a weak sister.

And yet, the world of mobile computing has come to be defined by smartphones and tablet computers, two segments where this tech giant’s market share is negligible, at best. But it wasn’t always this way. In 2004, Microsoft’s Windows Mobile operating system peaked at a 24% share of the cell phone market, and was projected to overtake Nokia’s (NOK) Symbian OS as the leading platform by the end of that decade. (More on Nokia and its current woes shortly.) The events that followed should serve as a cautionary tale, delivering a simple yet salient message: Dominance is not a birth right.

It would be difficult to identify a single moment, product, or decision that led Microsoft’s mobile division to its current predicament. Because there wasn’t one. This was the proverbial `death by a thousand cuts’. The company built a powerful, functional, highly-versatile operating system, and then let it wither on the vine. As a case in point: Windows Mobile was at one time the go-to platform for the business set, thanks to its ability to run MicrosoftWord, Excel, and other productivity software.

Accustomed to getting its way, Microsoft grew complacent, and allowed a relatively unknown Canadian firm to steal its thunder in the enterprise space. The name of that company, of course, is Research In Motion (RIMM), and its BlackBerry operating system caught Microsoft—and much of the cell phone market—completely off guard. (For more on Research In Motion and its candidacy, stay tuned for Part 3 of our series.) BlackBerry is widely considered the first mass market smartphone operating system, and appealed to business-oriented customers because of its security, reliability, and instant messaging capabilities. Almost overnight, most other devices were relegated to `dumbphone’ status, a term used derisively to describe handsets with basic features. Even the phrase `cell phone’ has since become an anachronism, since smartphones of today are essentially mobile computers in the palm of your hand. The end result: Microsoft’s once enviable market share has slowly dwindled to about 4% of devices.

For most other companies, that would likely mark the end of the story. Indeed, it would be yet another example of a pioneering product that failed to adapt to a rapidly-evolving market. For the group from Redmond, Washington, it was an embarrassing episode for a company unfamiliar with failure. But it may have also marked a turning point. Chastened, Microsoft has spent much of the past two years quietly retooling its mobile strategy, and started by scrapping its venerable, but hopelessly outdated, Windows Mobile platform.

The mobile division reemerged in late 2010 with a completely new operating system, rechristened Windows Phone 7, which elicited positive comments from the tech community for its clean, innovative interface. However, the new OS also drew criticisms for being `incomplete’, since it lacked basic features—such as the ability to cut-and-paste a word or sentence—that had long been incorporated into competing systems. It also didn’t help that Windows Phone 7 launched on what many deemed underwhelming hardware. Though a force of nature on traditional PCs, Microsoft was viewed by most of the world’s leading smartphone manufacturers as an also-ran, a label that undoubtedly resonated with a company that built an empire on the strength of its partnerships with hardware makers.

The fact is, many of its long-time collaborators in the mobile space, namely Motorola Mobility (MMI), Korean giant Samsung, and Taiwan’s HTC, had moved on during Microsoft’s absence, gravitating to Google’s fast-growing Android operating system. That message came through loud and clear, and Windows Phone 7 ultimately launched on a slate of so-so handsets to a lukewarm reception by consumers.

Knowing all too well that great software married to mediocre hardware is not a recipe for success, Microsoft shocked the tech world in February when it announced a strategic partnership with handset maker Nokia. The exact financial terms are still hard to pin down, but the deal entails Microsoft licensing its Windows Phone 7 software to Nokia in exchange for royalties. In addition, cash will flow the other way with Microsoft paying the Finnish company in excess of $1 billion to develop and build Windows Phone 7 devices and for access to Nokia’s extensive patent portfolio. Adding a bit of palace intrigue, Nokia had ousted its long-time CEO in the months immediately preceding the deal, replacing him with Microsoft veteran Stephen Elop.

Though both parties were quick to label the deal a partnership, many industry watchers dubbed it an acquisition, with Mr. Elop serving as Trojan horse, paving the way for his former colleagues at Microsoft to take over a faltering Nokia. Conspiracy theories aside, there is some logic to that line of thinking. Microsoft, relegated to an afterthought by many of its hardware partners, found in Nokia a handset maker renowned for exceptional industrial design and peerless fit and finish, but saddled with uncompetitive software and plummeting market share in the all-important smartphone space. Meanwhile, Nokia instantly became the preferred hardware partner of the world’s leading software company, with access to a promising operating system, as well as Microsoft’s financial and marketing might.

Microsoft’s nascent mobile platform got another boost via its recent $8.5 billion acquisition of Skype, a leading provider of Internet-based communications. Skype’s software facilitates voice over Internet protocol (VoIP), a technology that allows users to make phone calls using their Internet connection. Microsoft plans to tightly integrate that ability into its future devices, and will market Skype alongside other features such XBOX gaming capability, its Zune music service, and its ubiquitous Office productivity software.

Challenges certainly remain, and Microsoft has, in the past, treated its mobile division as a second-class citizen. But we think the company has learned the lessons of the past and will make a serious push in the smartphone space.

Advantages:

• Vast, vast, vast resources

• Multitude of well-honed, cost-efficient distribution channels

• Consumers know the Microsoft name, thanks to a dominant share (85%-90%) of the PC market

• Windows Phone 7 is a fresh, innovative operating system

• Well-known products, including XBOX, Zune, Office, and now, Skype

• World class Nokia hardware

Disadvantages:

• Has a history of acquiring promising technology/companies, then letting them die on the vine

• Big company syndrome: Difficult to stay focused on a vast array of products/markets

• Consumers know the Microsoft name, bound to have disappointed some in the past

• Windows Phone 7 is still very green, with a dearth of developers and applications; lacking functions

• Though a global brand, Nokia has almost no presence in North America

• Lack of strategy/products in the fast-growing tablet market

At the time of this article’s writing, the author did not have any positions in any of the companies mentioned.